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(originally published by Booz & Company)


A Global Financial Governance Primer

Such measures could raise the barrier to entry for smaller banks, leaving the playing field largely to FIs that are deemed “too big to fail” (TBTF) and that may thus require significant capital injections. The industry would then consolidate into a few global players, supported in effect by the governments of their host countries. If the U.S. is one of only a few economies with the scale to support global institutions, will other nations feel the need to prop up national champions that would otherwise not be competitive? More fundamentally, do we want global banks or national banks to dominate the industry?

Most proposals that address the TBTF problem rely on regulating complex FIs more tightly. An alternative is to address the root cause — namely, to prevent FIs from becoming so big in the first place. Options for doing so include antitrust or anticompetitive measures, and levying capital charges on institutions in proportion to the level of systemic risk they pose. In effect, that would charge these institutions a market price for their TBTF guarantee.

However, if a financial institution ultimately is nationalized, the role of the state as a significant shareholder will need to be understood to avoid potential conflicts of interest (for example, the use of FIs to drive policy). Likewise, government-based shareholders need to determine how they want to manage the potentially conflicting objectives of their portfolios of companies. Do they want to focus on supporting the economy, promoting lending, or making a modest return on their investments on behalf of their shareholders (the taxpayers)?

Overseeing Appropriate Risk

It is debatable whether a heavier degree of regulation will actually make financial institutions safer. Throughout 2008, markets, not regulators, provided the first signals of crisis. The true riskiness of FIs and financial transactions can best be determined closest to the source of risk buildup. Proposals for different types of FIs need to take into account their different risk profiles. This asymmetry of information and the lack of transparency are likely to lead to a more restrictive level of regulation than would be optimal.

In that light, the objective of financial regulation should be not to identify and reduce risk per se, but rather to ensure that the risks are dealt with appropriately by those financial institutions that are best equipped to handle them.

Author ProfileS:

  • Alan Gemes is a senior partner with Booz & Company in London and the global head of financial services for the firm. He has worked with many of Europe’s leading banks and insurers.
    Peter T. Golder is a Booz & Company principal in London with the financial-services practice, specializing in corporate strategy, capital markets, and risk management.
    Thorsten Liebert is a Booz & Company principal in London with the financial-services practice, specializing in corporate strategy, retail and corporate banking, and risk management.



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